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Phillip Frost's Opko Health shares are soaring, but The Fool's Michael Douglass and Todd Campbell worry that valuation has become a bit stretched. Here's why.

FDA approvals are a constant guessing game, especially when new drugs are developed for underserved markets. One man is trying to change that.

With his serial acquisitions of biotech companies, Phillip Frost is working toward total domination of the biotech space, giving him the lead on the development of pharmaceuticals for the lesser-known consumers' needs. As the creation of Opko Health(NASDAQ:OPK) is in full swing, he's sticking his fingers in the proverbial pies, grabbing a piece of the action from every corner of the market. But will it pay off for investors, or should these pieces make a more recognizable puzzle before buying?

A full transcript follows the video.

Michael Douglass: Opko Health. Interesting company, but is it a buy? This is Industry Focus.

Hi, Fools! Healthcare analyst Michael Douglass on the phone today with our healthcare contributor, Todd Campbell. This is Wednesday June 24th, and this is Industry Focus. So let's hop right into it. Opko Health, a company with a lot of interest, also a lot of short interest while we're on that topic. I'm sure we'll get to that in a minute.

Let's start with the interest in Opko. It's really centered around Phillip Frost. Todd, take us away.

Todd Campbell: Yeah. Phillip Frost is probably as close to a legendary healthcare entrepreneur as you're going to find.

Douglass: In the industry that doesn't necessarily have a ton of legends.

Campbell: Yeah. He's been around for a long time, and has been an entrepreneur for a long time. He's probably best known for taking Ivax, a relatively small company back in the '80s, and turning it into a global generics powerhouse that he was able to sell to Teva Pharmaceuticals(NYSE:TEVA) about 10 years ago for $7 billion.

He went on from that to take the leadership role at Teva, served as their chairman until this past January; but just because he was at Teva doesn't mean he wasn't very active in helping to foster along other innovative, new healthcare companies, including Opko health, which is his "favorite child."

Douglass: That's probably a good way to put it. He owns over 300 million shares of Opko. There's certainly some financial incentive in there, too.

Campbell: He has been a major acquirer of the shares since 2013, steadily going in and buying shares in their company when it was a sub $10 stock. Now the stock has climbed 50% or more since then, and that has made his stake worth around $4 billion in Opko Health alone. So he has a major stake in this company. He left Teva to spearhead it, he's now engaged full time in the role of leader of Opko Health; and for that reason, there are a lot of people that believe that Opko Health could be a very significant company over the course of the next decade.

Douglass: Sure. You mentioned he really likes acquiring shares of Opko, and he's certainly taken that acquisition idea and pushed it forward with Opko, which has been a "serial acquirer." Most recently, there's the big BioReference Labs, a $1.5 billion deal. Do you want to start with that, and then we'll work our way back?

Campbell: Sure. Describing him as a serial acquirer is actually brilliant. That's a great way of looking at it. Frost has always been a big believer in building something where the sum of the parts is greater. He did that with Ivax, and he's doing it again with Opko. Yes, the recent buy of BioReference, where they spent $1.5 billion to acquire the third-largest lab company, is an important one. We'll talk about that in a minute, but that's far from the first deal that he's done. He's orchestrated three significant deals over the last three years through Opko.

First was the acquisition of Rolapitant, a drug for the treatment of chemotherapy-induced nausea and vomiting. He was able to acquire that from Schering-Plough when they were merging. He was then able to license that drug back out, and Tesaro has since filed for approval of that drug, with an FDA decision expected in September. If approved, that drug will kick off double-digit royalties on any sales. That was one really strong acquisition that could soon be paying off for him. He also picked up a company called Cytochroma for Opko Health that landed him a drug named Rayaldee.

Rayaldee is a vitamin D hormone that's used in chronic kidney-disease patients -- a very underserved market -- and that could be worth $3 billion on the market a year, or more. They've already filed the application, and if that wins FDA approval next year, it could have two sources of revenue from those acquisitions in a relatively short order. Then, not including the BioReference deal, the third deal was to buy Prolor Biotech, which landed him a long-lasting human-growth-hormone drug.

He paid $480 million to buy Prolor, and earlier this year, he was able to license the rights to that drug back out to Pfizer(NYSE: PFE) for $295 million up front, $275 million worth of potential milestones, as well as potential royalties and profit sharing. So he's orchestrating a series of deals, and he's able to commercialize them in relatively short order.

Douglass: Yeah. It's interesting because they're going after all these drugs, and they have the 4Kscore prostate cancer test. I think one of things a lot of folks think when they look at Opko Health is, "How do those fit together?" Everything here seems different. It makes sense: If you can spend $1 to make $2, you should do it, but at the same time, it does feel a little scattered of a strategy with Opko. At least when I took a look at them it did. What's your take on that, Todd?

Campbell: Yeah. I think because of the thought of, "Let's get all these great ideas together and try to commercialize them," it creates the message that's a little muddy with Opko. As a result you have a lot of people who don't fully understand the story, and they're betting against the stock because they don't understand what the potential could be. I don't want to say that they're wrong to bet against it, but I think we need to remember that Frost has a history of being able to cobble together a lot of deals that are seemingly unconnected, and then be able to tie them up into a nice bow where they all dovetail very well together.

I think, in this case, he's building himself a franchise of drugs that are serving under-penetrated markets, or markets that need innovation, and by buying BioReference Labs and getting them a very large network of deals with health insurers and other payers, he's strengthening the ability to go out and not only get these drugs into the market, but commercialize them effectively. One of the things I think is really important about this most recent deal with BioReference Labs isn't how it relates to other drugs -- like the human growth hormone -- it's more, "How will it benefit his 4Kscore prostate cancer test?"

Douglass: Right.

Campbell: That test is theoretically revolutionizing how doctors evaluate patient's risk for prostate cancer. Traditionally, if you have someone you think is going to have prostate cancer, you'll go through a biopsy. Biopsies can be painful, they can create complications, and they're very expensive. Through Opko, Frost was able to develop a non-invasive test that has a very high success rate, and costs a lot less money than the traditional biopsy. However, after launching last year, sales so far haven't been blockbuster.

The reason behind that is, he hasn't been able to line up deals with healthcare payers. Now, by buying BioReference, he goes in already having these relationships that BioReference Labs has, and he can now leverage those to get this test reimbursed -- hopefully at favorable prices. So I think while you might look at this like there's a lot of moving pieces; you almost have to give Frost the benefit of the doubt based on his history.

Douglass: In that case, are you willing to give Frost the benefit of the doubt? This is a company that's got $350 million in cash, $120 million in debt, it's got $900 million annualized combined sales -- assuming BioReference Labs revenue -- but that market cap.

Campbell: Yeah. This is too pricey of a stock. It's hard to make a case. Ultimately, at Motley Fool, we're trying to dig into stories and see whether or not there's investing...

Douglass: Opportunity.

Campbell: Opportunity in them. At this price, I'm just not convinced that you can rush out and say "Yes! I need to join Phillip Frost in this quest!"

Douglass: Yeah... $7 billion is pricey. That works out to about 8x sales.

Campbell: Yeah. BioReference Labs is a profitable company. What's interesting about it is, it's transformative in that it's taking Opko, which was previously at $100 million runway in sales, and turning into a company with $900 million in sales in the chance to turn profitable next year. It's transformative, but you're still talking about a company that's trading at eight or nine multiple sales, and unknown multiples to future earnings.

With market cap north of $7 billion, until these drugs get approved and you actually see them start to generate out meaningful money for Opko that would allow you to say, "It's really only trading on 5x forward sales," I think it's too tough to make the case that the risk/reward is balanced in favor of going out and buying at this level.

Douglass: Yeah. I think that makes sense. I'll even say I'm a bit more bearish than you, but I think it's a fine watchlist stock, and certainly, as we see some parts of the strategy get knit closer together, I think there may be a buying opportunity, particularly if the market cap comes down a bit. I'm not a believer that biotech always has stretch valuations. You and I have talked about this before, and longtime Industry Focus listeners will recall some of those conversations. I think, in this case, the valuation just doesn't justify something immediately.

It's definitely a company to keep an eye on. I think the big thing to highlight is, if this ends up being a company that transforms healthcare in some various, meaningful ways, there will be lots of opportunities to get in. This isn't the sort of thing where a good opportunity is going to disappear today, or tomorrow, or this week, or next week, or even this year. If there is a really big, transformative opportunity with Opko long term, there will be lots of times when you can hop in and make a big difference.

Campbell: Yeah. A former mentor of mine used to say, "Stocks don't go up in a straight line." I think the message there is that there will likely be opportunities along the way to take a look at this at a better valuation. When you look at the short interest in the stock, you look at the potential volatility. I think it just makes sense to wait on the sidelines for that opportunity.

Douglass: That sounds good to me. All right, Todd. As always, thanks for your $0.02. Folks, tune into the Industry Focus podcast. We are here five days a week. Be sure to subscribe and hop on. Energy is tomorrow, on Thursday, and we'll look forward to hearing from you then. Please, always feel free to shoot us an email if you have any questions, want clarifications, want to talk about a stock, or concept. If there's something that we mentioned that you just want to hear more about: industryfocus@fool.com. That's industryfocus@fool.com. Please reference "healthcare" so we know to send it to this particular show.

Again, I'm your host Michael Douglass. On behalf of the Motley Fool, all of the hard-working folks here and across Fool.com, thanks for listening. Fool on! We'll talk to you soon. As always, people on this program may have interests in the stocks that they talk about, and the Motley Fool may have formal recommendations for or against those stocks. So don't buy or sell anything based solely on what you hear. Thanks much!

Author

Todd has been helping buy side portfolio managers as an independent researcher for over a decade. In 2003, Todd founded E.B. Capital Markets, LLC, a research firm providing action oriented ideas to professional investors. Todd has provided insight to a variety of publications, including SmartMoney, Barron's, and CNN/fn.
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